Year-End Tax Planning Tips for Individuals
With year end fast approaching, it's time to consider tax planning moves that may lower taxes for the 2022 tax year — and possibly set you up for tax savings in future years as well.
The good news is that it now appears that there won't be any significant unfavorable federal tax changes that will take effect this year or next year. Assuming that's an accurate prediction, the tax planning environment this year end is better than it has been in past years, when Congress was considering unfavorable federal tax change proposals.
Fortunately, those changes didn't happen, leaving you with some familiar tax planning strategies to consider.
Play the Standard Deduction Game
The Tax Cuts and Jobs Act (TCJA) basically doubled the standard deduction amounts. For this year, the standard deduction allowances are:
$12,950 for single people and married individuals filing separate returns,
$19,400 for people who use head-of-household filing status, and
$25,900 for married couples filing jointly.
Slightly higher standard deductions are available to those who are 65 or older or blind.
If your total itemizable deductions for this year will be close to your standard deduction allowance, consider making enough additional expenditures for itemized deduction items between now and year end to surpass your standard deduction. Those extra expenditures will allow you to itemize and reduce your 2022 federal income tax bill.
The 2023 standard deduction allowances will be significantly bigger thanks to a hefty inflation adjustment (that hasn't been announced yet). So, you can claim the bigger allowance next year if you don't itemize. The standard deductions for 2023 will be:
$13,850 for single people and married individuals filing separate returns,
$20,800 for people who use head-of-household filing status, and
$27,700 for married couples filing jointly.
The easiest itemizable expense to prepay is your mortgage payment due in January. Accelerating that payment into this year will give you 13 months' worth of itemized home mortgage interest deductions in 2022. Ask your tax advisor to determine whether you're affected by limits on mortgage interest deductions under current law.
Next, take a look at state and local income and property taxes that are due early next year. Prepaying those bills between now and year end can lower this year's federal income tax bill, because your total itemized deductions will be that much higher. However, the TCJA limited the amount you can deduct for all state and local taxes to a maximum of $10,000 ($5,000 if you use married filing separate status).
However, beware: Prepaying state and local taxes can be unhelpful if you'll owe the alternative minimum tax (AMT) for this year. Under the AMT rules, no deductions are allowed for state and local taxes. So, prepaying these taxes before year end may do little or no tax-saving good for people who are subject to the AMT. While the TCJA eased the AMT rules, so most people are no longer at risk, take nothing for granted. Check with your tax advisor about possible exposure.
Other ways to increase your itemized deductions for 2022 include:
Make bigger charitable donations this year and smaller donations next year to compensate, and
Accelerate elective medical procedures, dental work and expenditures for vision care if you think you can qualify for a medical expense deduction. You can claim an itemized deduction for medical expenses to the extent they exceed 7.5% of your adjusted gross income (AGI).
Harvest Gains and Losses in Taxable Investment Accounts
If you hold investments in taxable brokerage firm accounts, consider the tax-saving advantage of selling appreciated securities that have been held for over 12 months. The federal income tax rate on net long-term capital gains recognized this year is 15% for most individuals, although it can reach 20% at high income levels. The 3.8% net investment income tax (NIIT) can also kick in at higher income levels. So, the actual federal income tax rate on long-term gains can be 18.8% (15% plus 3.8%) or 23.8% (20% plus 3.8%) for some taxpayers.
If you're holding some losing investments — that are currently worth less than you paid for them — consider sellin
g them between now and year end to trigger the resulting capital losses. This year-end tax-saving strategy is called harvesting capital losses. Harvested losses can shelter capital gains recognized this year. Sheltering short-term capital gains with harvested capital losses is an especially tax-smart move, because net short-terms gains are taxed at higher federal income tax rates that can reach 40.8% (37% plus the 3.8% NIIT) for high-income taxpayers.
If selling some losing investments would cause your 2022 capital losses to exceed your 2022 capital gains, the result would be a net capital loss for the year. It can be used to shelter up to $3,000 of 2022 higher-taxed income from salaries, bonuses, self-employment income, interest income and royalties ($1,500 for married individuals filing separately). Any excess net capital loss can be carried forward indefinitely.
A capital loss carryover can be used to shelter short- and long-term gains recognized in future tax years. This can give you extra investing flexibility in the future because you won't have to hold appreciated securities for over a year to get a lower tax rate. You'll pay 0% to the extent you can shelter gains with your loss carryover. If your tax rates go up after this year, capital loss carryovers into 2023 and beyond could turn out to be even more valuable.
Important: If you sold a home earlier this year for a taxable gain, as many homeowners did to take advantage of peaking prices, you can offset some or all of that taxable gain with harvested capital losses from selling losing securities.
Give to Charity
You can make gifts to your favorite charities in conjunction with an overall revamping of your investments in taxable brokerage firm accounts. But there are two tax-smart principles to keep in mind.
1. Don't give away investments that are currently worth less than what you paid for them. Instead, sell the shares and book the resulting tax-saving capital loss. Then, you can give the cash sales proceeds to charity — plus, if you itemize, you can claim the resulting tax-saving charitable write-offs.
2. Donate investments in appreciated securities directly to charity. Why? Because, if you itemize, donations of publicly traded shares that you've owned for over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift. Plus, when you donate appreciated shares, you escape any capital gains taxes on those shares. Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing any federal income tax.
Give to Loved Ones
The principles for tax-smart gifts to charities also apply to gifts to relatives. That is, you should sell losing investments and collect the resulting tax-saving capital losses. Then give the cash proceeds to loved ones.
On the other hand, give appreciated shares directly to relatives. When they sell the shares, they'll probably pay a lower tax rate than you would.
Make Charitable Donations from Your IRA
IRA owners and beneficiaries who have reached age 70½ are permitted to make cash donations totaling up to $100,000 annually to IRS-approved public charities directly out of their IRAs. You don't owe income tax on these qualified charitable distributions (QCDs), but you also don't receive an itemized charitable contribution deduction.
The upside is that the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can potentially delay itemized charitable write-offs. Contact your tax advisor if you want to hear about the full benefits of QCDs. If you're interested in taking advantage of this strategy for 2022, you'll need to arrange with your IRA trustee or custodian for money to be paid out to one or more qualifying charities before year end.
Prepay College Bills
If paid for you, your spouse or a dependent, higher education expenses may qualify you for one of the following tax credits:
The American Opportunity credit equals 100% of the first $2,000 of qualified postsecondary education expenses, plus 25% of the next $2,000. So, the maximum annual credit is $2,500 per qualified student.
The Lifetime Learning credit equals 20% of up to $10,000 of qualified education expenses. The maximum credit is $2,000 per family.
For 2022, both higher education credits are phased out if your modified adjusted gross income (MAGI) is between:
$80,000 and $90,000 for unmarried people, or
$160,000 and $180,000 for married couples filing jointly.
Numerous rules and restrictions apply to these higher education credits. If you're eligible for either credit, consider prepaying college tuition bills that aren't due until early 2023 if it would result in a bigger credit this year. Specifically, you can claim a 2022 credit based on prepaying tuition for academic periods that begin in January through March of next year.
The Inflation Reduction Act of 2022 (IRA) provides some tax incentives for you to make energy-efficient improvements to your home, such as solar panels, energy-efficient water heaters, heat pumps and HVAC systems. The new law also extends, increases and modifies a tax credit for new home construction that meets certain requirements. These provisions go into effect after December 31, 2022. So, you might need to delay certain purchases until the 2023 tax year to take advantage of any tax-saving opportunities. Contact your tax advisor for guidance.
Also, if you're in the market for a new or used vehicle, the IRA provides tax credits for buying certain "green" vehicles. Under the IRA, starting on January 1, 2022, the plug-in vehicle credit will be called the "clean vehicle credit" and the manufacturer limitation on the number of vehicles eligible for the credit will be eliminated.
Important: The IRA changes how the clean vehicle credit is calculated. Specifically, a vehicle must meet critical mineral component requirements and battery requirements, plus final assembly of the vehicle must take place in North America. There are also price and income limitations. Starting in 2023, this credit isn't available to taxpayers with MAGI over:
$150,000 for single people,
$300,000 for married couples filing jointly, or
$225,000 for heads of households.
If you have income above these levels and you're contemplating a clean vehicle purchase, consider doing it before year end to qualify for the credit — but make sure that the vehicle you choose meets the qualifications and isn't made by a manufacturer that's already reached the 200,000-vehicle sales cap.
In addition, starting in 2023, used vehicles may qualify for a lesser federal tax credit if they meet certain requirements. The credit for used green vehicles isn't available if the lesser of your MAGI for the year of purchase or the preceding year exceeds:
$75,000 for single people,
$150,000 for married couples filing jointly, or
$112,500 for heads of households.
Unlike the credit for new cars, no requirements regarding final assembly or materials and components sourcing apply. Additional limitations do apply. For example, you generally can't claim the credit more often than every three years.
Is a Roth IRA Conversion Right for You?
Converting a traditional IRA into a Roth account is a tax-smart move when you expect to be in the same or higher tax bracket during your retirement years than you're currently in.
However, beware: There's a current tax cost for converting. A conversion is treated as a taxable liquidation of your traditional IRA followed by a nondeductible contribution to the new Roth account. But if you put off converting until some future year, the tax cost could be higher if tax rates go up or the value of your account is higher.
After the conversion, the income and gains that accumulate in the Roth account, along with qualified withdrawals, will be federal-income-tax-free. In general, qualified withdrawals are those taken after you've:
Had at least one Roth account open for more than five years, and
Reached age 59½, become disabled or died.
With qualified withdrawals, you (or your heirs) avoid having to pay higher tax rates that might otherwise apply in future years. While the current tax hit from a Roth conversion is unwelcome, it could turn out to be a relatively small price to pay for some insurance against higher future tax rates.
Contact Your Tax Pro
Consult with your tax advisor to discuss these and other federal (and state) tax planning moves that may apply to your situation for 2022.
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